Financing a college education follow-up – 529’s not so bad after all

As I stated, I am continually learning during this investigation of paying for college and learning the pros and cons of each investment vehicle.  In the previous article, I talked about the disadvantages of the 529 and suggested the IRA was a better option.  Well… upon further review… I may have been premature in my conclusion.

The information I provided was correct but it left out some key information.  First, when calculating need-based financial aid, income has a much greater impact than does the assets of the parents.  Also, you submit a financial aid application (FAFSA) each year and are evaluated each year.  Anyone figure out where this is going?

If you save for college in an IRA, yes, your assets are not counted in the FAFSA calculation, but when you make your penalty free withdrawals, you will be inflating your income for next year’s FAFSA.  This will have a great affect on every FAFSA after your first year of college.  So, by saving in the IRA, you will have more need based aid the first year, but after that, you will have less.

So, in hindsight, the 529 is a better vehicle for saving for college than either an IRA or a Roth IRA.  Anyone know how withdrawals from a life insurance policy is treated and how that could be used to fund college?  It will be awhile before I will have a chance to investigate this as I have term life insurance, but I am open to new information and would like to share.

Saving and purchasing a college education

So… I have learned so much in the last 6 months that I never knew about saving and paying for college.  The 2 things do inter-relate and laws change all the time.  Here are a few things I didn’t know.

Finanacial Aid Qualification

Do you know what assets are counted as assets and which assets are not when qualifying for student aid?  I didn’t.  I found out when filling out the FAFSA form that IRA/401k assets are not counted, but 529 assets are.  So maybe you are asking “why is this a big deal?”  The real question is “what is the benefit of 529 accounts?”  529 accounts allow post tax contributions (contributions are not tax deductible) to accumulate tax free with no taxes assessed when withdrawn.  This is very similar to a Roth IRA.  The only benefit I can find is that contributions are state tax deductible with no state tax assessed when withdrawn.  But does this one advantage make up for the fact that all your contributions will now be counted against you when trying to qualify for grants/aid?  In my opinion, no.  I think either contributing to a Roth IRA or a regular IRA is the way to go.  This gives the student the best chance at qualifying for aid and not just loans.

American Opportunity Tax Credit

This one came as a bit of a surprise to me.  Here is how it works.  For the first $2000 in education expenses, you receive a $2000 tax credit.  For the next $2000, you receive a 25% tax credit, which doing the math, is up to $500.  I have a decision to make since you can only use this tax credit 4 calendar years.  Do I use it for the fall semester where my son will be going to Community College and cost less than 4000 or for his last semester at a university?  Will the credit still be around for his last year of college?  Hmmm…. more research to be done on that.

Another interesting little thing about 529’s is that you cannot use funds from a 529 to pay for college and still receive the tax credit, but you can use funds from other sources, including IRAs and even student loans.  Strike 2 against the 529.  And… Well, that is just stupid.  If you pay for the first 4000 with funds other than your 529 and use the 529 to pay for school beyond the first 4000, then you can still qualify for the American Opportunity Tax Credit.  This is what I will be doing.

Community College

Unless your child is getting a full ride somewhere, seriously consider your community college.  For my son, it was much more obvious that it was the best option for him.  He wants to go into Meteorology and, due to personal ties, we were very aware of the strength of the Meteorology program at College of Dupage.  But… we learned they have many more great programs.  Did you know that the University of Illinois has a great Engineering program?  Yeah, you probably knew that.  But did you know that the College of Dupage has a 2 year program that, if you meet the GPA qualifications, you will automatically be accepted into the U of I Engineering program?  Well, they do.  They also have a 3+1 nursing program with Benedictine University.  Also, their counselors work with you to make sure that what you are taking can transfer to the college you want to go to.

Is the College of DuPage the only community college like this?  I doubt it.  Check out your own community college.  It may not be right for everyone, but don’t make assumptions about it.  I admit, when I was a lot younger, I used to thumb my nose at community college.  I used to think that was for students that couldn’t get into Universities or just didn’t want to go to college.  I’m not proud of that opinion, but it was what I thought.  Boy, was I wrong.

With College of DuPage, it is $140 a credit hour for in district students.  With tuition and books, I am estimating between 6 and 6.5k a year.  The government, through the tax credit, will refund 2.5k back leaving only 3.5 to 4k a year left for me.  Not bad.  If COD was a 4 year college, I would definitely have enough saved up for my son’s education.

So to summarize, check out your community college or a family member’s community college where you son or daughter could “live” to see if there are programs that would be a good option for them.  Also, remember the tax credit and that 529’s are not usually a great option for saving for college.

I welcome comments and if you have corrections or additional information, I would be happy to include them here.